Let me start with something I often
see in class.
A student once asked me:
“Sir, why would anyone pay more than ₹1,000 for a bond that will only return
₹1,000 later?”
That’s a very genuine question.
And honestly, if this confusion is
not cleared properly, bond premium and discount will always feel illogical.
So let’s sit together and break this
down like we would in a real classroom.
What
is Bond Premium and Discount? (Simple Understanding)
Think of a bond as a loan
certificate.
When a company or government issues
a bond:
- They promise to pay interest (coupon) regularly
- And return face value (say ₹1,000) at maturity
Now here’s the twist:
👉 The bond may not always
sell at ₹1,000
It can sell at:
- More than ₹1,000 → Premium
- Less than ₹1,000 → Discount
Simple
Definitions:
- Bond Premium:
When issue price > face value
- Bond Discount:
When issue price < face value
That’s it.
But this is where most students
think:
“Okay, I memorized it.”
👉 No. That’s not
understanding. That’s just remembering.
Why
Does Premium or Discount Exist? (The Real Logic)
This is the heart of the topic.
Ask yourself:
👉 Why would someone pay
₹1,100 for a ₹1,000 bond?
The answer lies in interest rate
comparison.
Think
of it like this:
- Bond gives fixed interest (say 10%)
- Market interest rate keeps changing
Case
1: Bond at Premium
Suppose:
- Bond interest = 10%
- Market interest = 8%
Now tell me:
Would you prefer:
- Bank FD giving 8%
OR - Bond giving 10%?
Obviously 10%.
So people are ready to pay extra
to get that higher return.
👉 That extra amount = Premium
Case
2: Bond at Discount
Now reverse it:
- Bond interest = 8%
- Market interest = 10%
Would you still pay ₹1,000 for this
bond?
No.
You’ll say:
“Give it cheaper, then I’ll consider.”
👉 So it sells below face
value = Discount
This
is the real logic:
Bond price adjusts so that investor
gets return equal to market rate.
Where
Students Get Confused
In my teaching experience, students
often mix up:
- Interest rate vs Market rate
- Issue price vs Face value
- Logic vs Formula
One student told me:
“Sir, premium means profit, right?”
No.
👉 Premium is not profit. It
is just extra payment made by investor.
Real-Life
Example (Indian Context)
Let’s take a practical scenario.
Example
1: Government Bond
Ravi in Bhopal is comparing
investments.
- Government bond:
- Face value = ₹1,000
- Interest = 12% (₹120 yearly)
- Bank FD:
- Interest = 9%
Now Ravi thinks:
“I’ll earn ₹120 instead of ₹90.
That’s ₹30 extra every year.”
So he is okay paying:
👉 ₹1,050 or even ₹1,080
That extra ₹50–₹80 = Premium
Example
2: Corporate Bond
Now another case:
- Bond interest = 7%
- Market interest = 10%
Nobody wants low return.
So investors demand:
👉 “Sell it at ₹900, then we’ll buy.”
₹100 less = Discount
Step-by-Step
Solved Example (Very Important)
Let’s solve one properly.
Question:
A company issues a bond:
- Face value = ₹1,000
- Interest rate = 10%
- Market rate = 8%
Find issue price (simple
understanding approach).
Step
1: Calculate Annual Interest
10% of ₹1,000 = ₹100
Step
2: Compare with Market Expectation
Market expects 8% return.
So investor wants:
8% of investment = ₹100
Step
3: Find Required Investment
We reverse calculate:
If ₹100 is 8%, then investment =
₹100 ÷ 8% = ₹1,250
Step
4: Interpretation
Investor is ready to pay:
👉 ₹1,250 for ₹1,000 bond
So:
- Premium = ₹250
Decision
Insight:
Why ₹1,250?
Because:
₹100 ÷ ₹1,250 = 8% (market rate satisfied)
Comparison
Table: Premium vs Discount
|
Basis |
Bond
Premium |
Bond
Discount |
|
Issue
Price |
More
than face value |
Less
than face value |
|
Interest
Rate |
Higher
than market |
Lower
than market |
|
Investor
Feeling |
Attractive |
Less
attractive |
|
Example |
₹1,100
for ₹1,000 bond |
₹900
for ₹1,000 bond |
|
Return
Adjustment |
Reduced |
Increased |
Why
This Matters in Real Life
This concept is not just for exams.
It directly impacts:
- Investment decisions
- Mutual funds
- Government securities
- Corporate borrowing
Even banks and big investors
constantly evaluate bonds like this.
👉 If you misunderstand this:
You may think a “premium bond is costly” and avoid it — even when it gives
better returns.
One
Personal Teaching Story
I remember a student preparing for
CA Foundation.
He kept saying:
“Sir, discount is always good because we pay less.”
Sounds logical, right?
But when I gave him this situation:
- Discount bond at 6%
- Market rate 10%
He realized:
👉 Paying less doesn’t mean earning more.
That moment changed his
understanding.
Common
Mistakes Students Make
Let’s correct these early.
1.
Thinking Premium = Loss
Wrong.
You pay more, but you get higher
interest.
2.
Ignoring Market Rate
This is the biggest mistake.
👉 Always compare with market
rate.
3.
Memorizing Without Logic
Students try to remember:
- Premium = higher price
- Discount = lower price
But forget WHY
4.
Mixing Face Value & Market Value
Face value is fixed.
Market value keeps changing.
Wrong
vs Right Thinking
|
Wrong
Thinking |
Right
Thinking |
|
Premium
means expensive, so bad |
Premium
means higher return bond |
|
Discount
means cheap, so good |
Discount
may mean lower return |
|
Focus
on price only |
Focus
on return comparison |
Practical
Impact (Business + Exams)
In
Exams:
- Questions come in:
- Theory
- Numerical
- Concept-based MCQs
👉 Examiner checks your
logic, not just formula.
In
Business:
- Companies decide:
- At what price to issue bonds
- Investors decide:
- Whether to buy or not
Where
This Concept is Used
- Debenture accounting
- Investment analysis
- Financial markets
- Government securities
- Corporate finance decisions
Exam
Tip (Important)
👉 Always write reason:
Instead of writing:
“Bond issued at premium”
Write:
“Bond issued at premium because coupon rate is higher than market rate”
This gives you extra marks
Reflective
Questions
- If a bond gives 9% and market rate is 11%, will it sell
at premium or discount? Why?
- Would you personally buy a premium bond? Under what
condition?
Power
Line
👉 A bond’s price does not
depend on its face value — it depends on how its return compares with the
market.
Quick
Recap
- Bond price ≠ always face value
- Premium → higher than face value
- Discount → lower than face value
- Reason → comparison with market interest rate
- Focus on return, not just price
Practice
Questions
- A bond of ₹1,000 carries 12% interest while market rate
is 10%.
Will it be issued at premium or discount? Explain. - A bond offers 8% interest but market rate is 9%.
What will happen to its issue price? - Calculate issue price if:
- Interest = ₹120
- Market rate = 10%
Related
Terms
- Time Value of Money
- Debentures
- Yield to Maturity (YTM)
- Interest Rate Risk
- Present Value
Guidepost
Topics
- What is Debenture in Accounting?
- Difference Between Shares and Debentures
- How Interest Rates Affect Investments
FAQs
1.
Is bond premium a loss?
No. It simply means you are paying
extra for higher interest returns.
2.
Why do bonds sell at discount?
Because their interest rate is lower
than market rate.
3.
What happens at maturity?
Investor always receives face value
(₹1,000), not premium or discount.
4.
Which is better: premium or discount bond?
Depends on return, not price.
Compare with market rate.
5.
Is this concept important for exams?
Very important. Especially for CA
Foundation, B.Com, and MBA.
6.
Can bond price change after issue?
Yes, it keeps changing based on
market interest rates.
7.
What is the biggest mistake students make here?
Ignoring market rate and focusing
only on price.
Author
Bio
Hi, I’m Manoj Kumar.
I hold an MBA and have practical exposure to accounting, taxation, and business
concepts. Along with this, I’ve spent time guiding and explaining these subjects
to students in a way that actually makes sense to them.
In my experience, most students
don’t find commerce difficult — they just don’t get the right explanation.
That’s where I focus. I break down concepts into simple, logical steps so they
are easier to understand and remember.
Through Learn with Manika, I aim to
make commerce learning clear, practical, and useful — whether you’re preparing
for exams or trying to understand how things work in real life.
When I explain a concept, I always
focus on the logic behind it, because once that becomes clear, confidence
automatically follows.
Disclaimer
This article is for educational
purposes only and should not be considered professional advice.